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Saturday, June 27, 2009

What Banks Are Looking For to Grant a Loan Modification

It is quite true that banks are mostly not in favor of foreclosing homes. This is because the losses hat accrue in foreclosing are generally significantly higher than that which would be allowed by way of even a severely modified loan. This does not mean that anyone and everyone who applies for a loan modification will be granted one. Banks need to be quite convinced about the credit worthiness of the homeowner and the ability as well as willingness to make good the revised loan as per agreed conditions and time frames. Otherwise, there is no point in the bank allowing a loan modification.

When a homeowner (borrower) is unable to and stops making requisite payments, the loan qualifies to be categorized as a non-performing asset. The foreclosure of such a loan seeks to make amends in such a case and addressing all the resulting losses. In recent times, banks have been adversely affected by such a situation and hence take recourse to various actions and measures, some of which are unprecedented. Given the magnitude of the problem, banks are counting the cost of foreclosing and coming to the conclusion that it does not always make economic and business sense to foreclose as opposed to less harsh measures of loan modification which may result in smaller but bearable losses.

The crux of the issue that can turn around a non-performing asset into one that has some promise of return is that of the income of the homeowner. Does the homeowner have access to any funds for mortgage payments after all other costs? Again, what is the relative loss of foreclosing as compared to the loan modification? Can the homeowner make good on the promise of payment made in the loan modification proposal?

However, if the bank agrees to a loan modification and the homeowner still defaults on payments the bank's losses are higher. The loan modification allows the borrower a forbearance period which means that there are no payments to be made between the date of modification acceptance and the first due date. Also, the due balances are erased by either being forgiven or being added to the principle balance.

An example of the above principle could be as follows: Suppose the homeowner has not been able to pay for 4 months (120 days) and after loan modification has a forbearance period of 3 months more (90 days). In such a case, the bank does not get any payment for 210 days. The borrower is given a fresh start at 210 days. Now if the borrower (homeowner) starts defaulting again, the bank has lost 210 days and must go through with initiating the foreclosure process all over again. In the normal course, the bank may give the borrower a few months before NOD of filed, which adds to the bank's losses. If they auction the property then, they will get roughly the same amount they would have got if they had not modified the loan. However, they have lost 210 days as well as spent time, man hours and efforts for the loan modification which cost money and cannot be recovered. This is one reason that banks will take the pains to assess the ability of the homeowner to repay before ever agreeing to the loan modification.

Once the banks considers a loan modification, the homeowner has to make an Income Vs. Expense Statement so as to calculate the surplus or available income that the borrower has to service the mortgage, going forward on the revised terms. The bank is in its rights to ask the borrower to prove income in terms of tax returns, bank statements and the like. The form as attached is generally sought by the bank and banks are appreciative of those who take the trouble to fill out the forms fully and accurately. Transparency in filling forms is essential. If you fail to report debts you could have a sticky situation when it comes to making payments. It's always best to be quite honest and forthcoming in filling out income as well as expenses as this could well be the last chance to save your home. If the borrowed defaults on payments after loan modification, the bank will have no recourse but to initiate foreclosure at the very earliest.

As far as the income aspect is concerned, one can rest assured that it is not being fed by the bank to the IRS. Those who are self employed, can be a little more open about the tips or cash income they are able to generate. If the bank is not convinced about the income, it may deny the loan modification request. A lie in this regard could cost a homeowner a foreclosure. If the loan is modified, and the payments are on time, the note may not be revised. The loss mitigation department takes pains to inform borrowers that modification related information will not find its way to the IRS.

Loan modification calls for including the income of all persons in the household and not just those that are party to the home loan. This is different from the traditional refinances and purchases businesses, where the buyer's income is only assessed. For instance, in loan modification if only one spouse has taken the loan, the income of both the spouses will be considered. Rental income has to be included as also any income from part time or second jobs even if not all of it gets reported in the IRS tax form. Children who have any income would also contribute to the income side of the statement. The only condition is that it should be backed up with some documentation like bank statements or order forms. If it is cash income with less documentation, do ask the loss mitigation team in the bank for advice on it. Banks sometimes use judicious assessment and their sense of judgment to not as for proof of certain types of income that cannot generally be backed up by statements, like tips etc.

At the cost of repetition, it makes sense to understand the importance of the expenses or liabilities section which entails a lit more effort and level of difficulty as compared to the income section. Lenders are interested in a correct assessment of the fixed monthly expenses which are absolutely unavoidable. Luxury items have to go. For instance of you have a $700,000 payment on a boat, which is pending, the lender will have you sell it off. When it comes to a choice between your house and luxuries, the luxury items will have to face the axe. In most case however, borrowers are down to the line really and do not have much expenses they can curtail. If unnecessary expenses have not been curtailed, the bank will ask probing questions and if you still feel it is unavoidable you will have to justify hard to retain it. However, do realize that trying to sneak in unnecessary expenses exposes you to the risk of being denied the loan modification. Is it really worth it?

The form requires you to fill out the liabilities which you should do in line with your credit report. These figures will be scrutinized by the bank and run a comparison between the Income and Expenses worksheet. The numbers should tally as it displays thoroughness, carefulness and ensure that the numbers are not doubted by the loss mitigation analyst. If the numbers do not tally, however, questions will arise and they will run your proposal through a fine toothcomb thus ruining your credibility and trustworthiness. This can be easily avoided by carefulness and accuracy. If the proposal is clear and simple, the review time will be less and your modification will have much better chances of going through.

There are some items that do not figure in the credit report, which are soft expenses. The bank cannot ask for documentation on this as it's virtually impossible to put a tab on and calculate very accurately. These are run of the mill costs like gas, entertainment, food and clothing and other everyday expenses. If you have lowered expenses excessively and have more cash than necessary, you can maybe spend more in eating out so that the numbers look better. Banks do not have the time and resources to track each small expense like electricity, gas and utilities bills, telephone bills etc. if you need to add on the expenses you can visit the doctor for some ailment as only large medical expenses would be tracked. In any case, banks only go after the larger liabilities and expense items, which is why such small expenses work well for balancing the expenses side.

It is commonly known and acknowledged that reducing the principal balance is the best type of loan modification. But it calls for really thorough preparation and proposal formulation. The income and expense statements must be satisfactory and also, asset valuation must be accurate. Asset valuation is not easy under the present circumstances because houses undergo transactions like outright purchases, short sales and sometimes auctions which do influence the price. The price of a foreclosed property is not market value. There are also many homes under short sales, which means that ascertaining real value of a property or home is no easy task.

Homeowners are mostly not appraisers or real estate experts. Banks often use this against them to try and disbelieve and discredit their value assessment. Hence, supporting evidence helps. Having a realtor friend is very helpful. These folks can help you prepare a fair comparison of your home with recently sold homes in your area, as will appraisers who can help with a quick value certification.

Assessment of value is important, but not all. You have to add in research of what are the going rates for properties at foreclosures. You can also scan newspapers for auctions and get information on these. The bank is aware that foreclosures mean losses. You have to research the duration the properties are sitting in the market, the vacancy rates and the like. All this proves that you are diligent and smart. This can give extra weight and legitimacy to your loan modification proposal.


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